I am going to be speaking at USC this weekend and in poring over old PowerPoints (to create a new PowerPoint for my talk), I came across one with a fairly extensive China law bibliography of some of our most helpful posts. This bibliography is definitely slanted towards the legal issues that confront foreign companies doing business in China.

Earlier this year, China’s Supreme People’s Court of China promulgated various interpretations of various employment law issues. These interpretations were intended to clarify and for the most part, they did. In particular, what was once unclear about non-competes signed by China employees has now become much clearer. I am not going to compare the old rules on China non-competes with the new rules, in large part because many of the old “rules” were less than clear. This post is instead intended to set out what the new rules are so that you as a China employer can act accordingly.

Perhaps most importantly, the Supreme People’s Court has made clear the required compensation for a non-compete to be valid and to remain in effect. If an employee agrees to a non-compete provision, but the labor contract or confidentiality agreement (signed by the employee) does not mention the compensation the employee must receive as consideration for not competing, and the employee has in fact not competed, the court can award the employee up to 30 percent of his or her average monthly salary. If a 30 percent award of the average monthly salary is less than the minimum salary standard in the city, the minimum salary must be paid instead. The Court also made clear that the employee is entitled to such compensation no matter what the reason is for the employee having not competed. In other words, even if the employee’s not competing arises from the employee’s inability to find new employment, the employee is still entitled to compensation for not having competed.

The Court also clarified what it takes to terminate (or not) an employee non-compete:

An employer may terminate a non-compete agreement and thereby cease having to pay for that non-compete, so long as it pays the employee at least three additional months’ compensation for the non-compete. In other words, three months notice is essentially required to terminate the compensation requirement

An employee may terminate a non-compete if he or she has not been paid for three the required non-compete compensation for at three months by requesting termination of the non-compete agreement. Note though that this non-payment has to be the fault of the employer; the employee cannot deliberately avoid payment in an effort to cancel a non-compete.

Certain aspects of non-compete agreements in China have not changed and remain important, including the following:

An employment agreement may include provisions intended to protect the trade secrets of the employer. A non-competition agreement may be included in support of such protections.

The employer must pay reasonable compensation on a monthly basis to the employee during the term of the non-competition period.

Non-competition agreements are limited to executives, technical personnel and other personnel who have access to trade secrets. Cases have held that senior sales staff are included in this category. On the other hand, blanket agreements that apply to all employees are invalid.

The terms of the non-compete restriction must be “reasonable” in length of restriction, business scope and geographic area. A term in excess of two years is prohibited. The scope requirement is strictly interpreted. It is not sufficient that the employee is working in the same general area as the former employer. Competition must be specific and direct.

If the employee violates the terms of the non-compete agreement, the employee can be held liable for a payment of contract damages to the employer. The amount of contract damages must be reasonable. Excessive damages that are clearly punitive will be rejected.

Just as is true of any contract that you will eventually seek to/need to enforce in China, your non-compete/trade secret/employee contract should be written in Chinese as the official language.

Many American companies (at least outside California where employee non competes are generally considered invalid) love non competes and they use them as a matter of course with most (sometimes all) of their employees. Generally a non-compete agreement or a non-compete provision in an employee contract provides that the employee cannot work for one of the employer’s competitors and/or engage in the same business as the employer.

The well crafted non compete provision is usually limited to a certain period of time following the employee’s termination and also usually limited geographically. Just by way of example: if you own a small sushi restaurant in Peoria, Illinois, a well-crafted non-compete with your sushi chef might prohibit him or her from working as a chef at another sushi restaurant within a 25 mile radius. The poorly crafted non-compete provision might prohibit him or her from doing anything in the food business anywhere in the world for the next five years.

For obvious reasons, courts are loathe to enforce over-broad non-compete agreements simply because they do not think it fair or right to preclude someone from making a living at their profession or craft, especially when doing so poses no real threat to anyone. China’s laws on non-competes are not so different on this point, but they are quite different on others.

China’s Labor Contract Law specifically permits employers to include non-compete provisions in labor contracts or confidentiality agreements with their employees. But these sorts of provisions are valid only if all of the following are the case:

The employee is senior management or a senior technical person. China’s courts take this requirement very seriously and few employees will qualify.

The period of the non-compete and its geographic scope must be reasonable and the non-compete period must be for less than two years.

The employer must pay the employee during the non-compete period or the non-compete provision ceases to be valid.

Note again that for the non-compete agreement to remain valid after the employee has left the company, the employee must continue receiving compensation from the company. In other words, the employee must get paid for not competing.

How much must the employer pay the employee during the non-compete period? We used to advise our clients to put in the contract this amount and to make it between 30 and 50% of the employee’s salary, depending mostly on the locale. China’s Supreme Court recently issued some national level guidance on these payments and it appears that the terminated employee’s monthly compensation should be 30% of the employee’s average monthly salary over the previous year, or the local statutory minimum wage, whichever is higher. This 30% should be deemed the minimum; employees may be able to negotiate a higher amount when signing their employee contracts.

We used to tell our clients that they “might as well” put in a non compete clause into their contracts with their high level employees since they would always be free to back out of any payment post termination if they wished. I now have my doubts as to that advice going forward as the Supreme Court has said that though employers are free to terminate a non-compete clause at any time, they must pay three months compensation to do so. We will now be advising our clients to think a little longer and a little harder before just throwing in non-compete provisions.

What are you seeing out there with non-compete provisions in employee contracts?

China’s Labor Contract Law (which law applies to every employment relationship in China) is very clear: employers must pay their employees for overtime.
Though there are some exceptions, these exceptions are not nearly as broad or as easy to obtain as is widely believed.
Overtime payments are 150 percent for each overtime hour worked on a normal work day, 200 percent for each overtime hour worked on a day off, and 300 percent for each overtime hour worked on a statutory holiday. China considers forty hours per week as generally considered standard.
Though high level management and other staff can be considered exempt from overtime pay, to be so, prior government approval is typically required. To make matters even more complicated, local regulations definitely can vary on what constitutes an exempt employee and what is required by way of approval.
My firm has handled around a half a dozen cases where foreign companies came to us after having been sued for having failed to pay overtime. In every single instance, our advice and eventual action was to settle the claims because they were all valid. Interestingly, despite all of them having been valid, we were able to settle them for considerably less than full value because the employees were so desirous of getting a lump sum payment and fast.
I thought of these cases today after a reader sent me a China Daily article entitled, “Labor Disputes Skyrocket in Beijing.” The article talks of how “about 80,000 [Beijing] workers had been involved in disputes with their employers by the end of November, double the number of last year” and up from 26,000 disputes in 2007. The article then noted how “about 50 percent of the cases were related to overtime rates and payment” and the reader asked me if I had been seeing the same thing elsewhere in China with respect to foreign employers.
My answer was, “Yes.” Employees and ex-employees are suing their foreign employers in China way more now than just a few years ago and most of those lawsuits are stemming from a failure to pay overtime, a failure to pay sufficient wages without a written contract, or from a termination not provided for in the employee manual. We are finding these cases very easy to settle at a fairly reasonable cost, but virtually all of these could have been avoided with just basic care. There is no excuse for not paying overtime or not securing an exemption for your employees to whom you believe overtime is not necessary. There is also no excuse for not having a written contract with your employees or a written employment manual setting out the grounds for firing.
Oh, and if you think the person you are paying is an independent contractor and not an employee, there is about a 99.9% chance you are wrong and that person is, in fact, an employee.
What are you seeing out there?

The article gives facts behind what many of us already know: “the number of labor disputes heard by courts has skyrocketed this year.” I knew it because my firm’s handling of such matters has probably just about doubled in just the last three months. According to the numbers, employee cases have increased by 59 percent over last year. The article rightly ascribes this increase to three things: 1) the economic downturn; 2) “Ever since the implementation of the Labor Contract Law in January 2008, workers have become more aware of their rights and the legal avenues available to safeguard them:” and 3) A reduction of costs for such suits to at most 10 yuan.

We are finding that most of these cases involving foreign companies doing business in China arise from one (or more of the following):

Firing of an employee for a reason not explicitly mentioned in the employer manual or not having an employer manual at all.

Firing of an employee who was not paid overtime.

Firing of an employee who did not have a written contract.

Discontinuing a relationship with someone whom the “employer” never considered to be an employee.

Firing of an employee for whom the employer did not make required social insurance or pension payments.

The article makes clear the government’s position on all this:

We encourage enterprises to assume more social responsibility, and try not to lay off workers or reduce salaries. On the other hand, we suggest workers show more understanding toward enterprises in financial difficulties.
Still, courts will punish such violations as arbitrary retrenchment, and guide employees and enterprises in resolving disputes through shorter working hours, training shifts, temporary vacations or salary negotiation.

As bad as all this sounds, my firm’s experience with these cases has, almost without exception, revealed the following:

Those foreign companies being sued or threatened with legal action did indeed fail to abide by China’s labor laws. This is a good thing because it implicitly means that those companies that follow the laws are far less likely to get sued.

Even when the foreign company was clearly in the wrong, it has been relatively easy and inexpensive to settle these lawsuits quickly. Our experience says that the employees are very quick to trade some money now for not having to go through the uncertainty of collecting more money at some indeterminate future date.

The obvious takeaways from all this are that it does pay to comply with China’s labor laws (including those regarding overtime and payment of pensions) and that if you are sued, it pays to act quickly to try to settle. Settling quickly not only usually makes sense for the instant case, we are also finding that it makes sense to stay in reasonably good graces with the powers that be.

Back in November, 2007, in our post, “China’s New Labor Law — It’s A Huge Deal. Huge I Tell You,” we pretty much predicted this. The new law is not dependent on the government. It requires lawyer enforcement and there are plenty of hungry lawyers in China who will sue early and sue often on this. I can assure you of that. I predict these cases will continue to increase over the next year or two, but declining after that as the economy improves and as companies finally get wise to the fact that these laws are being taken very seriously and will not be revoked.

I remember a time (Reagan era, I believe), when there was considerable talk about greatly reducing public television (PBS) funding here in the United States. In response to this, PBS reacted like any good bureaucracy does. It threatened to terminate that which the people found most precious. PBS told everyone who would listen that it would need to cancel Sesame Street, a hugely popular educational show for children. Of course, this left reasonable people wondering why PBS would cut off one of its highest regarded and most watched shows, rather than one of the interminably dull shows that made up the bulk of its offerings. Local governments threatened with reduced funding have been known to threaten to halve their firefighting force. Again, reasonable people can only wonder why such a vital service would be the first to go.

Of course, neither PBS nor the local governments that threaten to halve their firefighting were really serious. They just were going after that which the public holds most dear in an effort to scare them into raising (or not lowering) funding. I believe this argument was at one time actually known as the Sesame Street defense.

There has been a bit of that in China of late with respect to China’s new labor contract law. Story after story is coming out of China of 3,000 factories here and 5,000 factories there and 60,000, no make that 120,000 factories having closed or moved to Vietnam because of the new law. Hogwash.

Employers in China are painting the new labor law as far worse than it really is because they believe doing so now might either influence the law’s yet-to-be-released regulations or perhaps even lead to a revocation of the law. I do not fault them for this, but, at the same time, I do think its impact needs to be kept in perspective.

China’s new labor contract law is a big deal (as we have noted on countless occasions ), but it is not earth shattering or paradigm shifting. It is a big deal because it shows China’s continuing evolution to rule of law and it is a big deal because the employees (pretty much for the first time in a long time) have won one. But, in terms of factories closing or moving to Vietnam because of it….we are just not seeing it.

I was asked about the impact of China’s new labor law by a Newsweek reporter the other day. She wanted to know about the impact this new law is having on my law firm’s clients in China. I told her how they have had to pay anywhere from $5,000 to $25,000 to clean up their employment contracts and policy manuals, including getting them into Chinese. I also told her how we are concerned about how to handle matters for those of our clients who typically hire employees seasonally. And that was it.

She wanted to know what our clients were saying about the new law and I told her they were just asking us whether and how we could help make sure they were complying. What about the impact on their business, she asked. Are they talking about that? Yes, a few of them have complained about the new law the same way people always complain about taxes. Have any of them left China because of the new law? No. Are any of them threatening to leave China because of the new law? No.

I then flipped the questioning and asked her if she was aware of a single well-run Western company that is claiming to have left China because of the new law and she was not aware of one either. She quoted me an AmCham survey saying that 20% of American companies are thinking of leaving China because of rising costs. I said that sounded about right to me and that there will probably always be around that number looking to move to a cheaper locale and that of these 20%, I would guess the overwhelming majority of them will stay in China when they discover the grass is no greener on any other side.

Which brings us to Vietnam. The talk was that all these companies would go to Vietnam. My thought is that if they have, Vietnam should be bulging at the seams about now, but it is not. Yes it is booming, but does anyone seriously believe it has seen 15,000 new factories since the first of the year?

My sense is that China has seen a number of factory closings of late, but most of these are domestic factories that produced low end goods, not Western companies doing business in China. I also have no doubt that many Taiwanese and Hong Kong and Korean factories producing the same sorts of goods have closed as well. But, it is not fair to blame even these factories’ problems solely on China’s new labor law as Beijing has instituted a number of policies explicitly aimed at marginalizing such factories so as to push China up the value chain.

As regular CLB readers know, we have been repeatedly preaching (right word) for some time about the massive impacts to expect from China’s new labor contract law, which went into effect just this year. Our consistent theme has been that disgruntled employees represented by Chinese litigators will bring an ill wind to all employers in China. To read some of our previous posts on this, check out the following:

The article starts out noting how despite lawyers having seen this coming, “implementation has been slow,” “litigation has picked up markedly” and “China’s new Employment Contract Law continues to pose huge problems for employers.” It need not be so bleak:

Employers who have been non-compliant in the past will be hit the hardest by the new law. But is the outlook really that bleak for all employers? The answer is no, not necessarily – for employers who have been largely in compliance with the 1995 Labor Law (which is supplemented, not replaced by, the Employment Contract Law), and who implement proper administrative procedures to ensure continued compliance going forward, the pain will be bearable.

The new law “effectively eliminates” consecutive fixed-term employment contracts. The Employment Contract Law limits fixed term contracts to two consecutive terms, after which an open term contract is required to be offered to an employee. However, it is unclear as to whether an employer has the option to simply let the second term expire without offering a new contract to the employee. Draft implementing rules will apparently address this issue; it appears that the new rules shall stipulate that an employer is obliged to provide an open term contract if so requested by the employee. This would effectively give employers only one fixed term opportunity to evaluate employees.

It is not clear when Beijing will issue the implementing rules but it is clear that “employers need to be more mindful of when employment contracts expire and need to properly evaluate the long term employability of employees during the initial term.”

The article states that “extensive press coverage of the new law’s employee-friendly provisions” has educated Chinese employees of their rights and led to “a significant increase in formal labor disputes.” They also predict (and I concur) that the number of labor disputes will increase “even further once the new Labor Dispute Conciliation and Arbitration Law comes into effect in May of this year.” The new dispute law will eliminate arbitration fees and extend from 60 days to 1 year the time by which employees must file their claims. For more on the dispute law, check out this post, entitled, “May Day Is Also New Law Day,” on the WSJ China Journal.

Employers will still be able to terminate employees for violating written company rules, but the new Employment Contract Law sets forth certain procedures employers must follow for even this to be the case:

For company rules to be enforceable under the Employment Contract Law, the employer must (i) discuss and seek feedback on proposed company rules with all employees or an employee representative congress, (ii) conduct negotiations with the union or an employee representative; and (iii) publish the rules. This effectively empowers a union or employee representative to bargain with employers over salaries, bonuses, training and other work-related benefits and duties. However, as the law currently stands this does not mean that unions or employees have veto rights over any rules.

The authors conclude their article by rightly positing “that non-action is no longer an option.”

Travis Hodgkins over at the Transnational Law Blog views the new labor law in a much brighter light as he sees it (rightly so, I might add) as further proof that China is evolving towards rule of law. To find out more about what Travis has to say on the labor law, check out his post, entitled, “A Reason to Have Faith in China’s Legal System: The Labor Contract Law.”

I would love to hear from employers (and employees) regarding their labor experiences since China’s enactment of the new law.

The Off The Record Blog just did a short, sweet, blunt post on the law in China that is only half right. The post is entitled, the “The Law is an ass and there you have it.” It consists of the following quote from “a prominent Chinese lawyer during a private discussion about China’s new Labor Law”:

“The problem with Western companies doing business in China is that you think laws are about compliance; Chinese companies realize they are just obstacles to be avoided.”

In fact, that is only half the problem. The problem is that BOTH the Chinese lawyer and the Western companies are acting rationally and correctly. The Western company has to comply because it will be an easy target if it does not. The Chinese company, on the other hand, can game the system and probably do just fine.

There is also a flip side to this. I had lunch earlier this week with co-blogger Steve Dickinson and Ben Dietz, a lawyer in my firm and who handles US side legal work for Chinese and other foreign companies. We discussed how difficult it is representing Chinese clients in the United States because they tend to spend so much time and effort seeking to avoid clear laws even when following the laws would be relatively painless and far less risky.

Looking on the bright side (at least for us lawyers), China is very slowly becoming more legalistic and I see the new labor law as a prime sign of that. That law probably comes closer than any other law in China in terms of having an equal impact on foreign and Chinese companies because much of its enforcement will come from disgruntled employees and ex-employees, as opposed to from the government.

“As is always the case with China’s laws, the real questions will be in whether the new laws are enforced, how they are enforced, and against whom they are enforced,” says China Lawyer Dan Harris, from Harris & Moure. But, he adds, “there is a feeling the new labor law is more likely to be enforced than the old and, in particular, will be enforced against foreign companies.”

The Christian Science Monitor article quotes Xin Chunying, the deputy chairwoman of the National People’s Congress Law Committee, as claiming “it would be in favor of foreign investors because local governments have great tolerance for them in order to attract and retain investment.”

The law is scheduled to come into effect on Jan. 1, 2008. It essentially requires employment contracts be put in writing within one month of employment, it makes hiring of temporary workers much more difficult, and it gives fairly clear recourse to employees whose rights have been violated.

The foreign investors with whom my firm’s China lawyers have spoken regarding this new law do expect it will be enforced much more vigorously against foreign companies than as against domestic companies. We have written countless times how this is virtually always true of Chinese laws and we have every reason to believe this will be true of the China’s employment laws as well. This means that you as a foreign company must be sure to abide by every provision in this new law, even though you are being told by your Chinese “partner” that this is not necessary and even though you see domestic companies doing otherwise. For more on this foreign-domestic dichotomy in Chinese law enforcement, check out China Law: Selective Law Enforcement As Big Coincidence and The Painted Veil On Chinese Law.

We find many aspects of the new law to be rather vague and, in some ways, even somewhat contradictory. This is to be expected as the law has been worked out over a long time, with huge amounts of input from hundreds of thousands of people from all perspectives.

The proposed law very generally talks of how employment relationships shall comply with the principles of fairness and good faith and specifically mentions that the union shall assist in employee termination. But in dealing specifically with termination, the law gets quite specific and we presume the specific portions will trump this general, more politically palatable language.

The law permits for fixed term employment agreements which essentially expire. However, it appears employers may enter into only two fixed term contracts with an employee and on the third go round (or if the employee has been with the employer for more than ten years) the employment term must be open ended.

The law provides that an employer can terminate an open ended employee for what in the United States would be deemed “cause,” without having to pay severance. This includes the employee stealing from the company or working for another company. The law also provides that employers can terminate open-ended employees for incompetence, by providing thirty days notice or by paying thirty days in wages. The law does not appear to allow laying off one or two workers due to economics, so how “incompetence” ends up being defined will likely prove very important.

Overall, we see the law as a compromise that will improve things for employees more by its mere existence than by anything it specifically says. We anticipate the publicity surrounding the new law will serve to inform employees of their rights and perhaps embolden them to do more to enforce them. We do not see this (at least not in the short term) as doing much to increase labor costs for foreign companies doing business in China.

International mega law firm Baker & McKenzie posted an excellent English language translation of a very recent draft of the new labor law here and for those seeking more commentary on this new law, we suggest the following:

Korea already has a Labor Standards Act (LSA) which confers job security like you’re describing the Chinese act wants to provide. Boy, does the LSA suck. Its primary and signal defect is the arbitrariness of having such a law in an environment where only the foreign companies, and big Korean companies, give a dang about compliance. Smaller Korean companies are beastly employers, but there are so many of them — and they have so many other legal problems — that it’s not worthwhile for authorities to police them. So instead they focus on the errant multinational, who “ought to know better” because of the famous foreign brand.

Free legal advice to foreign employers: Fixed term contracts should start off at 12 months. Never hire anyone on an open-ended contract, which is employment for life ab initio, or a contract longer than 12 months (you can’t enforce the longer period against the Korean employee anyway). And before that fixed term contract has renewed a second time, make a decision whether you feel comfortable having the employee around forever. Because that’s the legal position after that contract has renewed twice.

From a competitive standpoint, as we hear the giant sucking sound over here in Seoul, we can say Hell, yes, China — do it! as an equally bad labor law will level the employment-law playing field. But on an objective level, it sure seems stupid.

Four things (at least) worthy of highlight from Brendan’s comment:

Tougher laws, without equal enforcement, are a way to camouflage discrimination against foreign companies. Korea and Japan are notorious for this.

Laws do influence where companies locate. It would be great if China’s labor laws were as protective as those in Sweden, but if they were, countless companies now in China will indeed move to places like Vietnam, where the laws are even more favorable to employers than in China. What is best for the Chinese worker? I am not calling for 70 hour weeks or no minimum wage, but at the same time, there has to be a balancing.

Good lawyers figure out how to use laws to their clients’ advantage and this means that laws relating to business rarely immediately succeed in fulfilling all of their goals.

Brendan Carr should start a Korean Law Blog. I know he is already one of the authors of Korea’s leading blog, The Marmot’s Hole, but I am serious. Brendan?

What do you think?

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About China Law Blog

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.